Interest Rate Worksheet - An interesting rate?

This worksheet focuses on different aspects of interest rate changes. It considers the effect of interest rates on aggregate demand, the use of interest rates as a tool of monetary policy and how interest rates in the UK are set.

There is also a printable version of this worksheet available for classroom or personal use with spaces to fill in the answers.

Step 1 - Demanding interest?

The interest rate will affect the level of aggregate demand. For more detail on this see the interest rate theory section.

Fill in below the components of aggregate demand:

If there is an increase in interest rates, what will happen to each of the components of aggregate demand? Fill in the table below:

Aggregate demand	Increase or decrease?	Why?
Consumption ( C )
Investment ( I )
Government expenditure ( G )
Exports & imports ( X - M )
Aggregate demand

Show the effect of increased interest rates on the equilibrium level of output on the diagram below:

Step 2 - Money and interest

The government also uses the interest rate to try to control the level of money supply growth. Use the Library (3rd floor) to find out why governments want to control the level of money supply growth. (N.B. Look at the 'Theory' section - Monetarists.)

Why do governments aim to control the growth of the money supply?

What theory is this belief based on?

How does an increase in the interest rate reduce the level of money supply growth?

Use your course book or notes to find out other techniques the government can use to control the level of money supply growth.

Use the interest rate theory section to find out how interest rates are set in the UK. Write a brief summary of this.

Use the same theory section to find out how the interest rate is maintained once it has been set. Write a brief summary of this.

Step 3 - Can you beat Eddie and the MPC?

Now try using interest rates for yourself to control the level of inflation. As Chairman of the Monetary Policy Committee of the Bank of England you have been set an inflation target of 3% over the next 10 years. Inflation must stay below this level.

Go to the model and see if you can achieve this. (N.B. You can also access the model from the 4th floor in the side panel and from the top navigation bar).

What changes did you make?

	1999	2000	2001	2002	2003	2004	2005	2006	2007	2008
Interest rate

What effects did these changes have on the rest of the economy? Record the results in the table below:

	1999		2000		2001		2004
	Before change	After change	Before change	After change	Before change	After change	Before change	After change
Inflation (%)
Unemployment (% of work force)
Economic growth (GDP growth) (%)

Say your inflation target is now reduced to 1%. Go once again to the model and see if you can achieve this target.

What difference has this lower target made to the other macroeconomic variables? Why do you think this has happened?